The U.S. is engaged in an ongoing debate about whether and how to transform its hybrid system of income and consumption taxation into a clean, simple tax system. A variety of alternatives to the current system have been proposed including switching to a clean (no deductions) proportional income tax, a clean proportional consumption tax, a flat tax (that taxes business cash flow plus wage income above a certain level), a progressive personal consumption tax, and David Bradford’s X Tax (that taxes wages at progressive rates and business cash flow at the top rate applied to wages),
Altig, Auerbach, Kotlikof, Smetters, and Walliser (1997) found that switching from the current U.S. tax system to a clean proportional consumption tax raises the long-run capital stock by almost one third and long-run output by 11 percent. Future middle- and upper-income classes gain from this policy, but inital older generations are hurt by the policy’s implicit wealth tax. Poor members of current and future generations also lose.
The flat tax, in contrast, improves the wellbeing of all members of future generations, but at a cost of halving the economy’s long-run output gain and harming initial older generations. Insulating these older generations through transition relief further reduces the long-run gains from tax reform. Switching to a proportional income tax without deductions and exemptions hurst current and future low lifetime earners, but helps everyone else. It also raises long-run output by over 5 percent. Finally, the X tax makes everyone better off in the long run and also raises long-run output by 8 percent. But it harms initial older generations who bear its implicity wealth tax.
Figure 1 and Table 1, reproduced from Altig, et. al. (1997), illustrates the model’s predictions for the case of switching to a clean consumption tax. Note that income class 1 refers to the poorest members of each cohort (those with the smallest endowment of human capital) and income class 12 refers to the richest members of each cohort (those with the largest endowment of human capital.) online payday loans direct lender